For retirees, it can be challenging to decide what to do with your money. Maybe you are not as active as you once were. Or, maybe you do not travel anymore. As your expenses start to minimize in retirement, one profitable recommendation is to give your money to charitable causes through Qualified Charitable Distributions (QCDs). Making qualified charitable distributions part of your overall financial and charitable giving strategy has five advantages.
What is a Qualified Charitable Distribution
Qualified Charitable Distributions (QCDs) are a feature of the US tax code that allows individuals who are 70 and a half years of age or older to make direct transfers from their Individual Retirement Accounts (IRAs) to eligible charities without counting the transfers as taxable income. The contribution can effectively support charitable organizations while reducing taxable income and avoiding certain taxes and penalties.
Reduced Taxable Income
One of the most significant benefits of making QCDs is they reduce your taxable income. The reduction in income is significant for individuals who must take required minimum distributions (RMDs) from their pre-tax IRAs each year, as these distributions are taxable. By making a QCD instead of taking a traditional distribution, individuals can reduce their taxable income and lower their tax bill.
Bob is retired and has a Required Minimum Distribution for 2023 of $60,000. He does not need the money to live but knows he has to withdraw it and pay taxes. Bob is in the 22% tax bracket with investment income, pension, and Social Security Income. Instead of withdrawing the money and letting it sit in his bank account, he donates $40,000 to charities. By doing so, Bob has eliminated $40,000 of taxable income and will be taxed only on $20,000. Not only does Bob feel good by donating to worry causes (instead of Uncle Sam), but he also eliminated $40,000 x 22% or $8,800 in taxes.
Avoidance of Taxes and Penalties
Another advantage of making QCDs is they can help avoid taxes and penalties that would otherwise apply to traditional IRA distributions. For example, individuals under 59 and a half taking a traditional IRA distribution will typically be subject to a 10% early withdrawal penalty. By making a QCD instead, individuals can avoid this penalty and take advantage of the tax benefits of charitable giving.
In addition, when filing your taxes, you can take advantage of the QCD tax savings and the standard deduction each year. Usually, charitable donations are itemized instead of taking the standard deduction. However, you can take advantage of both once you are 70 and a half years old.
Fulfillment of Required Minimum Distributions
Required Minimum Distributions (RMDs) are the amount individuals must withdraw from their pre-tax retirement accounts each year after reaching 73. In addition to avoiding taxes and penalties, QCDs can help individuals fulfill their required minimum distributions from their pre-tax IRAs. By making a QCD instead of taking a traditional distribution, individuals can simultaneously fulfill their RMD obligation and support charitable organizations.
The limit on this type of transaction is $100,000 per calendar year.
Supporting Charitable Organizations
QCDs allow individuals to support charitable organizations they care about and make a difference in their communities. Individuals can directly transfer their traditional IRA distributions to a charity to support organizations working on important causes and positively impacting their communities.
Making a QCD is a simple process that does not require individuals to write a check or go through the hassle of setting up a charitable trust. Instruct your IRA custodian to transfer directly to the charity; the donation is considered a QCD for tax purposes. The process makes giving convenient and easy for individuals looking to support their favorite organizations.
A Few Considerations
While QCDs offer many benefits, a few essential considerations exist when making these contributions. Ensure that the charity you give to is eligible for QCDs. Only qualified public charities are eligible to receive QCDs, and certain types of organizations, such as private foundations and donor-advised funds, are not eligible. Additionally, keeping track of the total QCDs, you make each year is vital, as there is a limit of $100,000 per individual.
In conclusion, Qualified Charitable Distributions can benefit an individual’s financial and charitable giving strategy. By making QCDs, individuals can reduce their taxable income, avoid taxes and penalties, fulfill their required minimum distributions, support charitable organizations, and simplify the giving process. If you are 70 and a half years or older and have a pre-tax IRA, consider making a QCD part of your charitable giving plan.
If you want to start a charitable giving strategy, please get in touch with us to start in 2023! We believe giving money to a charity instead of Uncle Sam is a more worthwhile experience for you.
About The Author
Jordan Benold, CFP® provides fee-only financial planning and investment management services in Frisco, TX. Benold Financial Planning serves clients as fiduciaries and never earns a commission or sells a product.